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Convertible bonds are different from other bonds because the bond holder has the right and not obligation to convert the bond into predetermined numbers of shares of the issuing company. This means that the bond also has an equity aspect -- the bond holder will make a lot of money if the stock price of the company increases. This money is usually more than a traditional bond. On the other hand, if the stock price goes down or stays the same, the bond holder gets interest payments in addition to his principal amount. This is unlike a stock investor who will lose his money if the stock price decreases.
A company who issues convertible bonds minimizes negative interpretations of its actions made by investors. For instance, if a company is already traded on the stock market issues fresh stocks, the market will see this as sign of the company’s share price being overvalued. To avoid this negative interpretation, the company may opt to issue convertible bonds and bond holders will convert these bonds to equity if the company’s financial performance is good. By using these bonds, the company is able to raise capital and pump that money into its operations so that performance improves and stock and bond investors benefit in return.
These bonds play a very important role in raising capital and many corporate tend to use this method rather than floating more stock and undermining the value of their organization.
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